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A Paradox of the Mean Variance Setting for the Long Term Investor

In: Models and Methods in Economics and Management Science

Author

Listed:
  • Abraham Lioui

    (EDHEC Business School)

Abstract

We show that the mean-variance preferences have counterfactual implications for a risk averse long term decision maker. In the simple case of dynamic portfolio choice, we show that the optimal certainty equivalent is decreasing with the investor’s horizon towards its lower bound, the riskless rate. For some horizons (less than 25 years in our simulations), the economic value of diversification is 0 and therefore the optimal portfolio strategy is a buy and hold one in the riskless asset. Therefore, under-diversification is optimal. These results question the usefulness of the mean variance setting for long term dynamic decision making.

Suggested Citation

  • Abraham Lioui, 2014. "A Paradox of the Mean Variance Setting for the Long Term Investor," International Series in Operations Research & Management Science, in: Fouad El Ouardighi & Konstantin Kogan (ed.), Models and Methods in Economics and Management Science, edition 127, pages 75-93, Springer.
    • Handle: RePEc:spr:isochp:978-3-319-00669-7_5
    DOI: 10.1007/978-3-319-00669-7_5
    as

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